UK economic activity: clear skies
10 July 2018
The ONS’s revisions to Q1 GDP did little to alter the impression that the UK economy suffered a sharp slowdown at the start of the year. Quarterly GDP growth was revised up slightly from 0.1% to a still weak 0.2%. This upgrade was due to methodological changes to how construction output is measured, which pushed up the previous estimate of a 2.7% decline in output to a much smaller 0.8% fall. The revisions also incorporated an improved contribution from net trade, with the quarterly trade deficit (as a percentage of GDP) the smallest since the first quarter of 1998. Other details were less encouraging. Much of the modest growth that was achieved in the quarter was attributed to inventory accumulation rather than domestic demand (see Chart 4). Business investment in particular was revised weaker, as Brexit-related uncertainty continues to cast a shadow over plans to expand capacity. Meanwhile, the household saving ratio fell to 4.1% from 4.5% in Q4 2017, though we expect that further drop to be temporary as households are likely to use the return to real income growth as an opportunity to rebuild savings after the period of dissaving that followed the referendum.
The flow of more timely data continues to point to a decent bounce back in activity in the second quarter, consistent with our view that weather effects accounted for much of the Q1 weakness. Services output rose by 0.3% in April, reversing the weakness in March, while forward-looking data have also been more positive. The services PMI moved up from 54 in May to 55.1 in June, the highest since October last year. And the manufacturing PMI ticked up to a three-month high of 54.4, a decent margin above the long-run average of 51.8. Together with a solid construction PMI report, this left the composite PMI at 55.0 (see Chart 5). Moreover, the services PMI does not include retail activity on the high street, which has also been buoyant in Q2, suggesting if anything the PMIs may be slightly understating the degree of strength. Against this healthy backdrop, June’s Consumer Confidence survey showed that confidence dipped slightly at the end of Q2, but remains in line with its long-run average. Overall, the data has been broadly consistent with our forecast for Q2 growth of around 0.5% q/q.
Under the new publication schedule for GDP data, which will see the ONS introduce monthly GDP estimates, the Bank of England will not have official data on Q2 activity before its August meeting. The new series makes use of data from VAT returns and the faster processing of service sector surveys, which the ONS hopes will improve the reliability of early GDP estimates and make them less prone to revision. We think it is unlikely that the lack of official Q2 data will to make much of a difference to the Bank’s decision making. Indeed, the MPC seems relatively confident about the economy’s recent performance. For example, Carney noted in a speech that “the incoming data have given me greater confidence that the softness of UK activity in the first quarter was largely due to the weather, not the economic climate.” He also pointed to labour market strength, limited spare capacity, and firm wage and pay growth. We therefore continue to expect that the Bank will hike rates by 25bps in August as it follows through on its limited and gradual hiking cycle.